The Trader

Mixed Data Keeps Stocks Flat for the Week

The major indexes were flat, though small stocks took it on the chin this week, a slightly ominous sign of things to come. Plus: Dollar General faces increasing competition from, well, everyone, and Lululemon shares are beginning to wear thin.

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Small-company stocks took it on the chin last week, dropping 3% in their worst showing since June. It's a slightly ominous sign, as the performance of riskier smaller stocks is often seen as a harbinger for the rest of the market. But the selloff wasn't reflected elsewhere; large-company indexes traded flat to slightly down on the week. Stocks moved on mixed data, including a disappointing U.S. jobs report on Friday.

Investors seem particularly conflicted about large stocks. The Standard & Poor's 500 has failed to express the same opinion on consecutive days in more than two weeks: It's been one day up and the next day down for 12 days in a row, a new record. But there are no trophies for those kinds of records, and generally no one gets rich.

Even as the S&P enacts its own version of Faye Dunaway's "she's my daughter/she's my sister" scene from Chinatown, the bulls show no hesitation or confusion. "It's a minor bump along the way," said Stuart Freeman, chief equity strategist at Wells Fargo Advisors. This is still a market that trades on the whims of central-bank officials, and there's no indication that they intend to take their feet off the gas pedal, Freeman says.

Retail investors also continue shifting slowly into stocks and out of cash and bonds, Freeman says. That should lead to higher price/earnings ratios for stocks. "We've just started to see that since the beginning of the year," he says. "Individuals are moving back into equities. It's still very early."

The Dow fell 13.29 points, or 0.09%, to 14,565.25 for the week. The S&P 500 lost 15.91 points, or 1.01%, to close at 1553.28, and the Nasdaq Composite lost 63.66 points, or 1.95%, to 3203.86. The Russell 2000 small-cap index fell 28.26 points, or 2.97%, to 923.28.

The monthly jobs report released Friday proved disappointing, as U.S. employers added just 88,000 jobs in March, against expectations for a gain of 200,000. The unemployment rate fell to 7.6%, largely because the labor force shrank. Despite the worst jobs reading since June 2012, investors didn't seem particularly shaken: After falling by about 170 points at 10 a.m., the Dow ended the day down just 41 points.

With the Federal Reserve keeping a close eye on the employment situation, the slump could turn in investors' favor. "This single employment report will not prompt a sea change in the Fed's thinking, but would act to push back the timing for starting to scale back asset purchases," says T. Rowe Price economist Alan Levenson.

The job numbers were "just an excuse to have a little bit of a selloff," said Martin Leclerc, chief investment officer of Barrack Yard Advisors. Even evidence that the U.S. economy is faltering won't rattle retail investors. "My sense is that they're not as scared as they were," Leclerc said. "It's funny what a doubling of the stock market will do."

That said, investors exhibited some caution. They turned to less risky assets this week—10-year Treasury yields fell to 1.698%, their lowest rate since December. Just last month, they were yielding more than 2%. Among S&P 500 stocks, only the utility, telecom, and health-care sectors rose.

Stocks could be tested next week, as first-quarter earnings season begins, although early results may not move the needle, says Freeman. "It will take a few weeks to see what direction we're heading in."

WITH THE ECONOMY TEETERING again, it's no surprise that companies are trying to capitalize on the woes of the cash-strapped American consumer. Unfortunately, every retailer got the same memo about strategies to entice shoppers, and that memo says "consumables."

"Everybody into the Consuma-Pool!" shouted a recent note from Nomura analyst Aram Robinson.

The shift has certainly hurt middle-market supermarket chains like
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(SVU). But the heightened competition could also hurt dollar stores, which are expanding at a rapid rate and are likely to butt heads with each other and with Wal-Mart.

Dollar stores caught a powerful tailwind in the recession that sent shares sharply higher. They stole market share from Wal-Mart as they capitalized on a trade-down effect among middle-class Americans.

But Wal-Mart is now trying aggressively to win those customers back, investing $1 billion this year to cut prices. The retail giant has also rolled out ads claiming its prices are lower than those of competitors like dollar stores, and opening smaller Neighborhood Markets to reclaim share.

But the dollar-store competition has gotten crowded in some neighborhoods: About 75% of Family Dollar stores are within three miles of a Dollar General, and 54% are in the same area as Dollar Tree, according to Credit Suisse analyst Edward Kelly.

Of the three, Dollar General arguably has the most to lose. It's the most efficient of the bunch, selling about $216 worth of items per square foot, versus $190 for Dollar Tree and $181 for Family Dollar. That efficiency gap has narrowed in the past couple of years.

Dollar General is still growing profitably, but earnings per share and same-store-sales growth could tail off this year. Dollar General's EPS rose 17% in 2012, and is expected to rise 9% in the current year. Same-store sales were up 4.7% last year, the slowest growth rate since 2008. This year, it expects same-store sales growth of 4% to 6%. Inventory began piling up in the last quarter, which will cause the company to mark down more items in the current quarter.

Dollar General is introducing cigarettes this year, which could boost traffic but hurt margins. In fact, the company now predicts that its gross margin will contract in 2013 after holding steady for the past four years. It trades at a price/earnings ratio of about 15, higher than Family Dollar and Wal-Mart.

Dollar General insiders recently announced they would sell 30 million shares in a secondary offering. Investors might take that as a cue.

Last month LuLu revealed that it would pull about 17% of its women's bottoms from shelves because they were too sheer, a step that will reduce fiscal first-quarter earnings by 11 to 12 cents a share, to 28 to 30 cents. Last week the company addressed the problem by announcing that Chief Product Officer Sheree Waterson will leave the company, and new quality testing and factory oversight will be implemented.

Investors responded by sending shares up almost 3% to $64.33 as shares already reflected much of the bad news, having tumbled from a high of $78 in September.

But what ails LuLu may not be resolved quickly. Customers have been complaining about product quality since at least August, when we wrote in The Trader of complaints online that fabric colors were running. Shares were at $56 and going short was too risky, given the size of the short position, but we recommended avoiding the shares.

The same advice holds today as the shares still trade at a lofty multiple, 32 times this year's earnings estimates, and customer complaints about product quality and consumer service are easily found on LuLu-themed blogs and on the company's own Facebook site. Making matters worse, customers aren't just griping, they're also touting yoga products they've found elsewhere. On Lululemon Addict, a blog devoted to all things LuLu, customers had a long thread discussing LuLu alternatives like Yogasmoga, KiraGrace, and Nancy Rose.

As you might expect, the competition has pounced. Recently, an UnderArmour advertisement running at the bottom of the Luluemon Addict blog reads: "The UA Bottom's Bar, Soft, Supportive and Tailored to a T. We've got you covered." UnderArmour declined to comment on whether the ad was referring to LuLu's sheer problem.

Customers can e-mail a picture or a receipt for any see-through yoga pants to Yogasmoga, at peekaboo@yogasmoga.com, to receive a $50 credit towards their purchase of the company's pants. The offer's kicker: Experience the Sheer Difference.

The offer is good on sheer yoga pants from any manufacturer, but it was introduced on March 20 in the wake of the LuLu announcement, says Rishi Bali, founder and CEO of Yogasmoga. The coupon appeared on the company's Facebook site, but after it was referred to on a few blogs, the response has been huge: 500 to 1,500 e-mails a day.

Quality problems may indicate LuLu expanded too quickly, asserts John Zolidis, an analyst at the Buckingham Research Group, who has an Underperform rating on the shares. The company is operating stores in the U.S., Canada, and Australia. It's growing square footage more than 20% a year, testing a second concept, and planning to open showrooms and possibly stores in 15 additional international markets. The company has encountered quality problems, depleted stocks, and slow checkouts.

"We believe LuLu's current growing pains suggest a need to slow square-footage growth and reinvest in the business, which could spark turnover in the shareholder base as growth investors reduce positions," he wrote in a recent report. His price target: $51. A LuLu spokesperson didn't return calls.

If overexpansion really is the root of the problem, it will take more than eliminating the chief product officer to right the ship. Keep your eyes on the Internet if you want to know when it's time to buy both yoga pants and stock. LuLu Internet chatter will let you know when all's well.